Disclaimer:
This Blog,its owner,creator & contributor is neither a research analyst nor an Investment Advisor and expressing opinion only as an Investor in Indian equities.He/She is not responsible for any loss arising out of any information,post or opinion appearing on this blog.Investors are advised to do own due diligence and/or consult financial consultant before acting on any such information.Author of this blog not providing any paid service and not sending bulk mails/SMS to anyone.

Saturday, January 10, 2015

VALUE TRAP

DEFINITION of 'Value Trap'

A stock that appears to be cheap
because the stock has been trading at low multiples of earnings, cash flow or
book value for an extended time period. Stock traps attract investors who are
looking for a bargain because these stocks are inexpensive. The trap springs
when investors buy into the company at low prices and the stock never improves.
Trading that occurs at low multiples of earnings, cash flow or book value for
long periods of time might indicate that the company or the entire sector is in
trouble, and that stock prices may not move higher.

Companies, and
even sectors, can be doomed, because of situations such as the inability to
survive competition, the inability to generate substantial and consistent
profits, the lack of new products or earnings growth, or ineffective
management. Often, a value trap appears to be such a good deal that investors
become confused when the stock fails to perform. As with any investment
decision, thorough research and evaluation is recommended before investing in
any company that appears cheap when reviewing its relevant performance metrics.

How to avoid Value Traps...

Of course, it's easy to say with hindsightthat a failed
investment was a value-trap but are there any ways to flag this in advance?
Fundamentally, the key to avoiding value traps is doing your homework and
exercising caution when approaching enticing investment prospects. It's
crucial to be as precise as possible about intrinsic value through
fundamental bottom-up company analysis. The other issue is that it's important
to have an adequate margin of safety since this is the value investor's
buffer against errors in the intrinsic value calculation. However, beyond that,
there are some common fact-patterns that it's worth watching out for....

Few Signs that Your Stock May be a Value Trap

1.
Is the sector in long-term secular decline?

A company may simply be serving a
market that no longer exists in the way it used to. No matter how good the
company, it will need a fair wind behind it eventually and and if the sector
itself is dying, it's likely to be a huge battle to realize value. From a
demand perspective, it's important to distinguish between cyclical
and secular declines. In the former case, short-term demand will
rebound with an improved economy. In the latter case, demand is in long-term
decline (e.g. due to societal and demographic changes), which means that the
remaining players are left to fight for a share of an ever-decreasing pie.

2. Is the risk of
technological obsolescence high?

Technological progress can radically reshape an industry and
its product lines - this can have a major impact on the life cycle and
profitability of a firm .One might assume that a stock is cheap enough to
compensate for decreasing cash flow but, sometimes, cash flows hits a tipping
point and drops off faster than you expect.

3.
Is the company’s business model fundamentally flawed?

Sometimes, a company may simply be
serving a market that no longer exists, or at a price-point that is no longer
relevant, given competition and/or new substitutes for the product.

4. Is there excessive debt on the
books?

More often
than not, financial leverage magnifies the pain of a value trap. Limited
or no financial leverage gives firms access to the the most precious commodity
of all - time! A company with no debt is unlikely to go under, barring a major
catastrophe (e.g. a massive legal settlement against it). On the other hand,
excessive leverage can destroy even a great company. For a good margin of
safety, the debt to equity ratio should be as low as possible and interest cover should be comfortable

5.
Is the accounting flawed or overly aggressive ?

It's best
to stay away from companies where aggressive or dubious accounting is employed.You should be “triply careful”
whenever management uses some metric that they define, rather than conventional
metrics .

6. Are there excessive earnings-estimate revisions?

Analysts are quite lenient and usually revise their estimates downward
before earning releases to allow companies to beat their estimates. Occasional missed
earning estimates can provide an opportunity to buy on the dip, but a pattern
of missing earning estimates may mean that management are struggling to
forecast properly, with a knock-on effect for the analysts, and/or that
management doesn’t understand or are not willing to fix problems.

7.
Is competition escalating?

Be careful of companies facing
increasingly stiff competition. Is there a tendency for the industry to compete
on price to squeeze margins? If there are limited barriers to entry and a
company is unable to differentiate itself, then it's possible that the market
structure has simply moved against it - it may never recover the glory years of
the past. One way to test this is to compare the historic profit margin trend
over the last 10 years. If the profit margins are decreasing, this may suggests
the company is unable to pass increasing costs onto its customers due to
increased price competition

8.
Is the product a consumer fad?

Another sign of a possible value
trap is a product that is subject to consumer fashion or whims. Evolving consumer
tastes and demand may mean that the market for the product is just a short-term
phenomenon

9. Are there any worrying
corporate governance noises?

It's worth checking for any history
or noise that suggests minority shareholders might be getting a raw deal .

145 comments
:

Dear VP sir, Happy new year, you have a amazing foresight to predict the companies future, I have been following you for last around 1 year, I was a more of a trader, where I missed all good companies trading in and out, as of now missed a good opportunit to create wealth, now I have planned to turn to a long term investor,I have picked some companies for long term can you please give your views on long term, 1. Skm egg. 2.atul auto, 3. Gruh fiance, 4. Repco home finance, can I be able to create a good amount of wealth from these. Thanks shailesh

Wish you a happy and prosperous new year.Hope you continue to helo small investors like us as we have leard a lot from you and will continue dng so.Sir, I have added SKM at belwo 100 price....But i have done research on this company and gone through yor viws o skm...I feel its a awesome company to own for long term..

Sir Could you plz plz let me know if I can add more at CMP.Your reply will also help people who have not yet invested but are are willing to invest in this gem... Plz plz reply sir...

Not sure why you are not in a position to take a decision after studying the company in details . Whether any stock is suitable or not is a decision only the investor can take based on his own risk taking capacity which is known only to him /her. Whatever I can do is - share whatever I know about the company .

I am owning Gujarat Borosil from 22 levels......Sir do you think that the recent developments in the solar sector will help Monopoly players like borosil...Also sir is there a chnage of competition from chinese player and will it impact borosil in a big way or small way......Plz do reply sir....as i want to invest more in GBorosil.

Sir thank you very much for the wonderful column, we are really indebted to your free service. Sir , SEBI changes the circuit levels for scripts from 20% to 10% or from 10% to 5 % or 5% to 2% .how will we know that the circuit is going to change in advance. Do they publish anywhere?? Kindly answer when you are free.Thank you.

Frankly speaking I don't know the benchmark they are considering to change circuit filters.Sometime they will reduce a 20 % circuit to 10 % once the stock hit two consecutive 20 % filter , but in some other cases 5 % circuits increased to 10 or 20

Can one park his money in tata Elxsi and forget .. Say 1% of his networth .. Its altogether in a different league ..no competition n brand name ..Look at marico kaya- a different business n competition n brand name .. Up 5 times

Sir, can I please know your view on Plastiblends. The CMP is 255 with a 52 week H/L of 312/93. The company has consistently reported increase in sales from 2005 onwards with OPM of 10%+, has been a consistent dividend payer. The book value is 116, zero secured debt and 31 crores of unsecured debt. The company has reserves of 130 crores and equity of 6.5 crores

Sir, your views on IG Petro please.It is an established market leader in Phthalic Anhydride (PAN) with strong recognition, excellent plant facilities and international standards of Phthalic Anhydride (PAN). Equipped with the third largest capacity in the world at a single location, the Company has the ability to meet competition not only in the local market but also in the international market. Phthalic Anhydride (PAN) is used in industries such as flexible PVC, plastics, paints, construction, transportation and marine

dear sirpls share ur view on Capital first , it is not moving with other finance companys like repco , bajaj, indiabulls etc and trading at low price to book. pls suggest i hold a good quantity. IS it a value trap

VP Sir I would love your views on Sutlej Textiles. It is a Rajasthan based company belonging to the KK Birla group. It is the largest producer and exporter of value added synthetic and blended dyed spun yarn in the country. It endured the 2008 crisis with only its debt increasing, but the debt levels are coming down. Can Textile sector be considered as long term bet? Will you consider Sutlej a valuepick?

Sir, wish you a happy pongal.. Framers are pride to our nation.. You being a farmer and doing a selfless work makes ahead from others.. Live long with all wealth and health.. Let's continue to learn from you sir!

Can you please explain why Hindustan Tin Works is not one such value trap? Packaging industry is moving to plastic more and more (with food grade plastic). I am looking for your expert analysis on this.The stock is refusing to move above Rs 80 now.

Sir, Neverdays i have been seeing in some bakerys trend is changing Plum cakes in small round Tin boxes, some famous Sweet shops selling some of its good swwets in Tin boxes. In Chennai there is a famous swwet shop Krishna Sweets, they are selling one of its sweet Cashew Bites in Tin boxes, which makes it attractive too. Got a sense of this from the various markeets, just wanted to share with you. Thanks a lot for guiding us always

Hello sir,first day here , someone told me that U r mahatma of stock market, I am curious to know ur most recent recommendations , and more importantly where did you get so much knowledge from. What makes you so intelligent in stock market? Yea, Super likes for the way you help others!

A BIG Salute to you VIP,I invested my fortune in JSPL, two years ago. After seeing little bit of up movement, the stock has fallen sharply from my purchase price and as on date am incurring a huge loss on it. Please advice whether to stay invested or shift the proceedings to other companies ??Your advice on this is the only ray of guidance.

Sir, First of all thanks a lot for identifying Multibase India at such an early stage. Got the chance to enter into it at 70 odd level's and today sitting on huge profits.... Indebted to You Sir..... Sir again the silly Question for you.... Time to Book some Profit or Hold on to it? Although i am a long term investor just want your guidannce.....

Company is not a bad one but recent sharp appreciation is due to govt's plans to make compulsory air bag option for passenger cards. If this decision get final nod , it may change the fortune of company but if there is any change for this plan , stock may correct.

Dear VP,I just saw in news channel a recommendation as MM Forging which you had already picked in your post in June 2014 and i was compelled to make this post as i wanted to appreciate your keen eyes which pick these kind of gems earlier than the commercial predictors....and i also wanted to ask you whether you think this stock could be bought at these levels ?

Hello VP Sir, What is your views on Kaveri seeds considering I haven't invested in this company yet. I have gone through your old posts but havent found anything after recent correction do you see any negatives or still good company to enter.

Hello, looks like MIC Electronics is having some legal trouble with their Nasik contract? Any change in your views? I know you suggested it for high risk takers, but is it ok for them also to continue to hold for long term?